“There is a danger that central banks jointly create an unnecessarily sharp global recession,” Maurice Obstfeld, an economist at the University of California, Berkeley, and a former chief economist of the International Monetary Fund, warned this month in a draft paper for the Brookings Papers on Economic Activity. That downturn, he and his co-author, Haonan Zhou, wrote, could happen “through uncoordinated policies that effectively export inflation to trading partners through actions that strengthen their own currencies.”
When Raghuram Rajan was the governor of the Reserve Bank of India, he wrote a working paper with Prachi Mishra, saying: “Aggressive monetary policy actions by one country can lead to significant adverse cross-border spillovers on others.” At the time the issue was cutting rates to combat slow growth rather than raising rates to combat fast growth, but the concept was similar. “If countries do not internalize these spillovers, they may undertake policies that are collectively suboptimal,” he wrote.
While Rajan and Mishra didn’t advocate direct coordination by central banks, they proposed a system of self-discipline in which the banks would code their actions green, orange or red, depending on the severity of their spillover effects on other parts of the world. (Don’t do the red stuff.)
But a lot of economists have serious misgivings about efforts by central banks to take into account how their actions will affect other nations. I spoke this week with Ayhan Kose, who is the chief economist of the World Bank’s equitable growth, finance and institutions group. He and two co-authors wrote a report this month called “Is a Global Recession Imminent?” It warns that the “mutually compounding” effects of central banks’ efforts to get inflation under control “could produce larger impacts than intended, both in tightening financial conditions and in steepening the growth slowdown.”
So you’d think Kose would favor coordination by central banks in the name of self-restraint. But no. Too tricky to get right, he said. “There are many things in life that we would like to do,” he told me. “And these are good things. But the question is, can we do them in an effective way? Policy coordination is one of them.”
Pulling punches in the fight against inflation would be a big mistake, Kose said: “We think inflation is the No. 1 macroeconomic challenge. Central banks need to be decisive, clear, credible and, if necessary, aggressive.”
Early in my career, when I covered Eastman Kodak for The Associated Press in Rochester, N.Y., I wrote about the Plaza accord of 1985, which was hatched at the Plaza Hotel in New York City. It was an agreement by five big industrialized nations including the United States to reduce the overvaluation of the dollar, which was harming U.S. exporters, such as Kodak. It worked, but it was an exception. For the most part, the big economies set interest rates for domestic conditions and let their currencies float freely.